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Strategies for small investors

Nikhil Lohade | August 10, 2004 12:28 IST

The refrain among fund managers today is that small investors are becoming more and more important to the stock market. Their numbers "give the market depth".

Also, with negative real interest rates, it makes sense for the small investor to look at the equity and debt markets to make some substantial long-term gains.

In this first of a three-part series, three fundmen unveil their strategies for the small investor.

Nilesh Shah, chief investment officer, Prudential-ICICI MF

Shah urges investors to follow three simple principles -- starting early, invest regularly and diversify the risks -- to multiply wealth over the long term. There is no other way to make money on your investments, he says.

Start early: The biggest benefit of this is compounding. It works in your favour 24x7. Your investment of Rs 1,000 at a rate of 15 per cent per annum would grow 133 times in 35 years. You would have to invest four times that money ten years later or 16 times 20 years later or 66 times 30 years latter to get the same return. The power of compounding can multiply your wealth in the long run.

Invest regularly: The simple rule of making money is 'buy low and sell high'. It is difficult to find where the low or high are. Markets have gone lower from 'rock-bottoms' and have gone up from 'peaks'. No one can predict the future.

The world's most successful investors don't have more than an average strike rate on their investment calls. They have made money by letting their profits run and by reducing losses. It is far better to invest regularly in a market, which keeps on going up and down (sideways too) and is difficult to predict.

Many investors have lost money in technology funds launched during the first quarter of calendar year 2000. A regular investment in those funds would have given a positive return by now. Regular investment in a wobbly market reduces the cost of acquisition over a long term. This 'rupee cost averaging' strategy works wonders for the investor even in a relatively flat market.

Diversify risks: Every asset class has its own risks. Actual or perceived loss makes investors take wrong decisions out of fear. A well-diversified portfolio (investments across different asset class like debt, equity, real estate and commodity) will reduce the chances of losses on a portfolio basis. This enables the investor to withstand volatility.

Ved Prakash Chaturvedi, CEO, Tata MF

Individual investors are often faced with a plethora of choices. There are bank fixed deposits, company fixed deposits, other instruments like bonds, insurance, mutual funds and often company IPOs all of which provide a confusing spectrum of opportunities.

Advertisements scream out to investors telling them about the benefits of each of these options. All this can be quite bewildering and confusing. The individual investor needs to sit back and think of some basic issues. I have the "rule of five" for any person who asks me how he or she should go about making an investment decision. This is in the form of five questions, which I will mention here.

  • Why am I saving? Is it for my post-retirement planning, is it for my child's education/marriage, is it for constructing a house, etc.
  • What are my current sources of earnings, what are they likely to be over the next 5 years, what is the surplus money available for savings over this period.
  • When would I want to redeem the savings and investments I make now or in other words how long can I make these savings for.
  • How much risk am I comfortable with or in other words what are the instruments where if I put the money I will not lose sleep at night.
  • Having decided my risk appetite, the purpose of my investment, the period of my investment and broadly my expectation of return, I would look at an appropriate mix of securities available in the market preferably by taking some professional financial advice.

This rule of five is a golden rule and has helped people I have advised in the past. In the current market conditions, while the fundamental performance of companies seems to be good, sentiment is depressed owing to concerns over international fund flows, monsoons, oil prices, inflation rates, etc.

This phase comes in every market once in a while when fundamental performance is good but sentiment is depressed and should be used by long term investors to appropriately position themselves based on their risk return appetite as discussed above.

Sashi  Krishnan, CEO, Cholamandalam  MF

Small investors need to go about their investments in a systematic way. The key to a systematic investment strategy is financial planning. Every investor needs to make a beginning on this front.

The first important step is to be clear as to what his future financial needs could be.

There are many investment avenues open to small investors but the best investment is that which allows him to sleep soundly at night.

Deciding which investment avenue is best suited for oneself is half the battle won.

To begin with an investor needs to determine his tolerance for risk. Typically asset allocation would vary on whether one is aggressive or conservative. The mutual fund route provides an easy and simple way for small investors to achieve their asset allocation goals.

The important thing for an investor is to select a fund that has an investment objective and risk tolerance that is similar to his own.

The mutual fund route not only saves investors time but also allows them to diversify their holdings and reduce risk. The added advantage is that investors can easily find a fund that matches their specific asset and risk allocation strategy.

The initial investment amount will also be small. As most of the funds are open-ended, investors have the freedom to make corrections in their asset allocation strategy depending on their changing financial goals.

The investor needs then to decide on how to divide his investments among equity funds, bond funds and liquid funds. Investment returns depend largely on how assets are divided among those three asset classes-not on the specific investments chosen within those classes.

In arriving at their asset allocation decision, investors should consider four important factors-their investment goal, investment time horizon and risk tolerance. In the 20-40 age bracket, the risk-taking capacity is higher, so investors should try to maximise wealth in this period.

Part II: Still more strategies for small investors

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